Auto Sales Surprise; Should You Be Buying?

John is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The recent retail sales report showed a surprise gain in motor vehicle sales.  Sales jumped 1% in the month of April after a 0.6% decline in March. Overall retail sales also surprised to the upside.

Based on the increase in motor vehicle sales and low oil prices, investors may see this as a good time to invest in auto manufacturers. However, there are several factors indicating that auto manufacturers may not be the ideal place to invest your money.

Uncle Ben

There is no doubt that Ben Bernanke's decision to maintain interest rates at historically low levels has helped bolster auto sales. The ultra-low Fed Funds rate has led to cheaper automotive loans for buyers looking to upgrade their automobiles. The website Bankrate.com reports that the average rate for a 60-month auto loan is just 3%.

Ultra-low interest rates, like all good things, must come to an end.  While there is no clear time frame in place, given the recent run-up in the stock market, rates could begin to rise in the near future. Depending on how quickly a rate hike is executed, a subsequent rise in auto-loan rates could put a strain on new-vehicle sales.

Europe

Europe remains in the midst of a terrible recession, and automobile sales have suffered dramatically. New vehicle registrations for the month of March were down 10.2% year-over-year, and represented the 18th consecutive month of declines.

Ford's (NYSE: F) sales slipped 15.8% for the month of March, and General Motors (NYSE: GM) saw an equally ugly decline of 12.6%. Auto-parts manufacturer Delphi Automotive (NYSE: DLPH) is also feeling stress from Europe, with first-quarter 2013 revenue decreasing by 17% from the prior year. Even European heavyweight Volkswagen saw its revenue drop 9% for the month of March. 

The European recession shows no signs of improving in the near term.  Unemployment remains at staggering and historically high levels, and a cohesive plan for the European Union still does not exist. Until the EU can find a way to improve the economy, the continent will continue to be a drag for auto manufacturers. 

European Response

The issues in Europe clearly pose significant threats to the financial strength of Ford and GM.  As such, the company's have created detailed response plans to address the needs of their European segments.

Ford is planning to bring an unprecedented 15 new global vehicles to Europe over the next five years in order to deliver a model lineup that is among the region's freshest to drive revenue. The company is also seeking to strengthen its brand image in Europe by emphasizing class-leading quality, fuel efficiency, safety, and value. 

Ford is also driving cost efficiencies in Europe by closing three facilities and reducing vehicle assembly capacity in the region by 18%.  Through these actions, the company plans to be profitable in Europe by mid-decade.  

GM is also looking to cut costs in Europe, and recently sold its transmission operation in France and closed a production facility in Germany.  The company hired a top executive from Volkswagen to serve as president of GM Europe starting March 1. 

GM also plans to launch no less than 23 new Opel/Vauxhall vehicles between 2012 and 2016.  The first two of the new vehicles were in segments GM did not previously compete in, and the company has seen strong demand for those vehicles. GM states that through these measures, it hopes to achieve break-even EBIT results by mid-decade.

While Delphi doesn't have a clearly articulated European plan like Ford and GM, the company's results in the region will likely be closely tied to the success of these companies. GM and Ford represented 24% of the company's sales in 2012.  Compounding the matter, Volkswagen and Daimler represent another 18% of 2012 sales. 

Valuations

Domestic auto manufacturers appear fully valued if not slightly overvalued.

Ford currently trades at a P/E of 9.6, well above its five-year average P/E of approximately 6.6.  Despite the problems in Europe, Ford has seen strong growth in US sales. As of April 30, US sales were up 12.7%.  

General Motors is trading at a P/E of 10.8 versus its five-year average P/E of 9.3.  The company also has an unimpressive start to 2013.  Revenue dropped approximately 2.4% from the same quarter last year and EBIT dropped by 18.2%.  

Delphi is trading at a P/E of about 14.4 versus its five-year average of 9.2.  The company also had a rough first quarter with revenue dropping by 6%, adjusted EBITDA dropping by approximately 3.8%, and EBITDA margins were compressed by 0.3%.

While investors can make the case that the higher P/E ratios reflect the strengthening US economy as well as the increasing strength of the US auto industry, the P/E's appear fully valued.

Closing

While the April retail sales report showed a nice surprise for motor vehicle sales, US automobile manufactures do not appear to be good investments at these price levels. The pending rise in interest rates will have an impact on sales as credit becomes more expensive. 

Historically, Europe has represented a significant portion of sales for these companies, and the continent shows no signs of improving in the near term.  While GM and Ford have been aggressively cost cutting and launching new vehicles, neither company plans for financial success in the near future.  Mid-decade profitability could just as well turn to late-decade profitability.  Valuations seem to fully price in any upside potential with little concern for future headwinds. At these levels, there are better investments to be found.

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John Timmes has a position in General Motors. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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